Fears of global liq­uid­ity crunch haunt Davos elites

The Pak Banker - - OPINION - Am­brose Evans-Pritchard

THE In­ter­na­tional Mon­e­tary Fund is in­creas­ingly alarmed by signs that mar­ket liq­uid­ity is dry­ing up and may trig­ger an even more vi­o­lent global sell-off if in­vestors rush for the ex­its at the same time.

Zhu Min, the IMF's deputy di­rec­tor, said the stock mar­ket rout of the last three weeks is just a fore­taste of what may hap­pen as the US Fed­eral Re­serve con­tin­ues to raise in­ter­est rates this year, push­ing up bor­row­ing costs across the planet.

He warned that in­vestors and wealth funds have clus­tered to­gether in crowded po­si­tions. As­set mar­kets have be­come dan­ger­ously cor­re­lated, am­plify­ing the ef­fects of any shift in mood. "The key is­sue is that liq­uid­ity could drop dra­mat­i­cally, and that scares ev­ery­one," he told a panel at the World Eco­nomic Fo­rum in Davos.

"If ev­ery­body is mov­ing to­gether we don't have any liq­uid­ity at all. We have to be ready to act very fast," he said. Ex Chi­nese cen­tral banker Zhu Min Photo: AFP Zhu Min said the worry is that pol­i­cy­mak­ers still do not un­der­stand the com­plex in­ter­ac­tions in the global fi­nan­cial sys­tem, where vast sums of money can move across bor­ders at light­ning speed.

What the IMF has ob­served is that mar­ket cor­re­la­tions are near an his­toric peak, with aligned po­si­tions in the US equity mar­kets four times higher than the av­er­age since 1932. This is a recipe for trou­ble when the Fed is tight­en­ing.

"When rates go up, mar­ket val- ua­tions have to ad­just," he said

Har­vard pro­fes­sor Ken­neth Ro­goff said the fear in the mar­kets stems from a dawn­ing re­al­i­sa­tion that the Chi­nese au­thor­i­ties are not ma­gi­cians af­ter all, and that this time the Fed may stand back and let the blood-let­ting run its course.

"What is driv­ing this is that the cen­tral banks are not com­ing to the res­cue," he said, speak­ing at a Fox Busi­ness event hosted by Maria Bar­tiromo. Rates are al­ready zero or below in Europe and Ja­pan, and quan­ti­ta­tive eas­ing is largely ex­hausted, leav­ing it un­clear what they could do next if the sit­u­a­tion de­te­ri­o­rates. Prof Ro­goff said th­ese deep anx­i­eties are caus­ing com­pa­nies to hold back in­vest­ment, en­trench­ing a slow-growth malaise. The Fed may be forced to halt its tight­en­ing cy­cle and even cut rates again if the wild sell-off con­tin­ues for much longer.

Prof Ro­goff said the events of the last year had de­mol­ished the myth that China is a "per­pet­ual growth ma­chine" and could some­how es­cape the curse of the busi­ness cy­cle. It is the last domino of the "debt su­per­cy­cle" to fall and the scale of it is the haunt­ing spectre now hang­ing over the global econ­omy. Na­ri­man Behravesh, chief econ­o­mist for IHS, said cap­i­tal flight from China has reached $1 tril­lion since the mid-2015. "It has been mas­sive. They have off­set it by run­ning down re­serves but do­ing this is a form of mon­e­tary tight­en­ing. So what are they go­ing to do now?

Mr Behravesh said China is trapped by the "Im­pos­si­ble Trin­ity", un­able to man­age the ex­change rate with­out los­ing con­trol over in­ter­nal mon­e­tary pol­icy within a con­text of (par­tially) free cap­i­tal flows. They are likely to opt for dra­co­nian cap­i­tal con­trols as the lesser of evils, he said. But the dan­ger for the world is that cap­i­tal flight spins out of con­trol and forces Bei­jing to aban­don its de­fence of the yuan.

"This all re­minds me of the ERM cri­sis in Europe in the early 1990s. There is a risk that we could see a 20pc de­val­u­a­tion of the Chi­nese cur­rency, and that re­ally would push the world econ­omy into re­ces­sion," he said.

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